Digital disruption – drivers, symptoms and scenarios

My students, colleagues, and leaders in firms who I mentor have been asking me to share my views on digital disruption of businesses. In this post, I try to define the contours of digital disruption and what it holds for the future of businesses, in my opinion.

What is digital disruption?

Disruption refers to a fundamental change in the value proposition of the business. When digital technologies form the basis of such a change, I call it a digital disruption.

Drivers of digital disruption

There are three primary drivers of digital disruption (adapted from this article). First, is the maturity of digital tools and technologies that uncover inefficiencies in traditional business models. Take for instance the sharing economy characterized by business models like Airbnb.com and Uber. These business models highlighted the underutilization of fixed assets in residences and cars, and shifted the consumer behavior from traditional business models of exclusive hotels and owned cars to shared residences and cars. A recent example of this sharing economy is www.flightcar.com, that allows for individual car owners to rent their cars parked idle in airports to other visitors to that city as self-driving cars!

The second driver of digital disruption is the increasing evaluability of performance parameters. In a traditional business like car hiring services, it was difficult to evaluate the quality of cars. In the sharing economy, ratings/ reviews/ recommendations from other users can help evaluate various parameters of the products and services. Uber allows for mutual rating of drivers and riders, alike. Such improvements in technology that increase the evaluability of parameters, hitherto not evaluable can significantly contribute to unique customer value addition.

The third driver of disruption is the increased dominance of mobile apps. What the transition from traditional PC-based software applications to mobile apps contributes is lower costs of customer adoption, richer data collection by the apps leading to better customization of experience, and mobility. Imagine using Uber through only a PC-based or a browser-based communication!

When do you know your business is being digitally disrupted?

The following table describes the characteristics and symptoms of digital disruption with some examples (adapted from this article).

Symptoms Examples
A proliferation of free or nearly free digital technologies in the value creation process Digital photography eliminating paper photography
Such technologies are provided by multi-sided platform firms Products like Gmail eliminating the need for organizations investing in their own email servers
Conscious shifting of value creating activities outside the firm, including open and user innovation processes Evolution of 3D printing enabling democratization of design and prototyping
Rapid prototyping and product development/ market entry made possible as a result of user/ open innovation Proliferation of platforms and forums like tech-shops that enable businesses and consumers to rapidly prototype and customize their products in low volume production contexts
Use of direct and indirect network effects to leverage economies of scale and scope Evolution of aggregators and marketplaces like Alibaba.com that leverage network effects for economies of scale and scope

Most digital disruptions are visible when the industry/ market is characterized by one of more of the above symptoms. If any of these symptoms are visible in your business context, organizations beware. Begin preparing to face/ counter these forces.

Planning for the digitally disrupted future

Prof. Mike Wade from IMD, Lausanne describes four scenarios of digital disruption (read the full report here).

  1. The global bazaar – industry and geographic boundaries blurring due to internet and mobile
  2. Cautious capitalism – data security concerns limit firms’ ability to monetize consumer data
  3. Territorial dominance – regional industry boundaries persist, with tight regulation
  4. Regional marketplaces – world divided into regional clusters with their own rules and governance, innovation fostered in regions with little or no international competition

The following figure summarizes the four scenarios with examples of firms that will dominate their respective markets. 13.1 Digital disruption scenarios

As you can see, these are just my preliminary thoughts, and I would strive to develop on them subsequently.

Comments, feedback, and experiences welcome.

Building a platform business is hard work, not for lazy people: A response to Prof. Ajay Shah’s column in the Business Standard

I read with interest what Professor Ajay Shah had to say about young men and women entrepreneurs of today wanting to become rich quick, with dreams of laziness in the Business Standard (see here). This note is a response to his observations/ allusions that businesses that run on network effects (a) are not-so-innovative, (b) operate in monopolies, and (c) are built around inferior products.

Building a platform is hard work, not for lazy people

Let me begin with the title – lazy businesses. The implication of laziness is that while there is opportunity and capability to do the hard work, these businesses (and by implication, its founders) are unwilling to work hard. I disagree to the notion that anything develops fast is not hard work. The implication that a business that grows slow is “steady” and the one that grows fast is cutting corners. True capitalism favours entrepreneurs who chase and capitalise on big opportunities, and that too pretty fast. Building network effects is not as easy as he alludes. He quotes the example of Google monopolising cloud-based email due to the network effects it has generated. Google was not the first entrant in the cloud-based email space, there were two large competitors operating when it entered – Hotmail and Yahoo Mail. Gmail entered with a disruption – it offered almost unlimited storage on the cloud, and two, it began with invitation only. It took a while for Gmail before it became open for signup, but given that innovative positioning of “never having to delete your email”, it was quick enough. Behind this innovation at the customer end was the hard work, the painstaking task of building server farms across the world with sufficient security and redundancy built into them. This is exactly the hard work Prof. Shah talks about, innovating around products – the Google innovation was riding on the falling storage costs and leveraging the power of global network connectivity to build a network of server farms, thus driving costs down. The fact that Gmail was able to unseat Hotmail and Yahoo Mail from their leadership positions is sufficient evidence that competition is working, and capitalism is safe too.

Platforms are innovative

One of the key tenets of capitalism is that factor endowments (like capital) flow freely from inefficient uses to the most efficient uses. The fact that the venture capital market is amply fragmented is the first signal that capitalism is working there. Let us turn to the platform business firms that seek these capital resources. As capitalism would have it, money should only flow to the most efficient uses of capital – ask any entrepreneur about raising money, and you would hear enough of how difficult it has been. Raising money has never been so difficult, as each of the business models have been unique. Yes, there have been replication business models that get funded, like I want to be build the Uber of Indian hospitals, but they are few and far between. Each of the business models that are flush with funds from the venture capital firms and angel investors are indeed innovative. May not be in the traditional sense of the product innovation like Google’s server farms, but a lot of them offer unparalleled service innovations. Take the example of Quickr, the C2C used goods marketplace. Though such used goods marketplaces had existed in the past, Quickr has managed to bridge the information asymetry between buyers and sellers in a variety of ways (photographs of products, contact details of sellers, premium services, and enabling within-platform communication through QuickrChat) as an insurance against the platform becoming a “market for lemons.” These innovations have not happened in one day, it has taken them years of competing with similar and local marketplaces and keenly listening to their customers on both sides – buyers and sellers.

Not all platform businesses operate in winner-takes-all markets

Prof. Shah alludes to the suggestion that most, if not all, platforms create and operate as monopolies, once they reach a threshold of network effects. Research in economics shows that there are three conditions for a platform market to become a winner-takes-all market – network effects are strong and positive, multi-homing costs are high for the users, and there are no special preferences for users. He has clearly defined the network effects in his article, and I would skip that part. Let me turn to multi-homing costs. Unlike switching costs which measure user costs of switching from one competing product/ brand to another; multi-homing costs measure the user costs of staying affiliated to multiple product/ brands. A good example of multi-homing costs is the number of emails accounts a user can efficiently own and operate. Even though most of cloud-based email is free to use, and a user can create any number of email ids for herself, what restricts her choices to a few is the costs of logging in to each email id, and making sure you do not miss out on important communication. This multi-homing costs ensure that the market has one social networking site, where people connect with friends, family, co-workers, as well as their business partners. However, not all markets have high multi-homing costs. Users (bargain hunters) do shop on multiple ecommerce sites and maintain their login/ passwords for each of these sites. The third condition for a market to demonstrate winner-takes-all economies is the absence of special preferences amongst the users. In the peer-to-peer networking space, where Facebook dominates the social networking market, professional networking (finding jobs and customers for one’s skills as a special need) has another player, LinkedIn. Passive job seekers would populate LinkedIn, while active job seekers would register with one of the many job sites like Naukri.com. The point I want to drive home here is that having network effects by itself does not guarantee a winner-takes-all economy. Firms expend time and effort in building multi-homing costs and enveloping any special needs to create a winner-takes-all market.

Successful platforms have a superior product/ service core

Though network effects make switching costs high, the history of platform business evolution is strewn with a lot of products/ services that have fallen by the wayside due to poor quality of its core product/ service. We did talk about Hotmail and Yahoo Mail, that did not innovate at the right time and lost out to Gmail. On the other hand, Friendster and MySpace failed due to Facebook’s superior quality and constant innovation. Google+ with the backing of the Internet giant, is an also ran in the peer-to-peer social networking space. Yes, switching costs exists and are non-zero, but given the right kind of strategy adopted by the challenger, that is apart from the superior product/ service, users can, and will shift.

Network effects are hard to build

Prof. Shah’s piece asserts that network effects are easy to build and can be done quickly too. Building cross-side network effects are difficult. How would Prof. Shah like to be the first contributor of a new newspaper, not as established as the Business Standard? He writes a column for the BS because of the existence of network effects – he knows that his columns would be read by the “right audience.” Traditional businesses like newspapers have long known to subsidize one side of its user base, its readers, while making money from advertisers (and in some cases, even benefactors and sponsors). So is the case with the media industry. This is a classic “chicken-ane-egg” problem that network industries have to resolve. There are many ways to solve them, and subsidising one side is just one of them. For instance, Practo has invested heavily in building its practice management software, Practo Ray for its clinics side of the business, so that it could build cross-side network effects. Now that the clinics use Practo Ray, Practo can afford to subsidise patients discovering doctors/ clinics through Practo.com. Tough, hard work buidling and selling practice management solutions to clinics, before the subsidising began. Subsidising one side of users to build network effects is not in itself any bad, but such subsidising should not be at the cost of overall economic well-being. Founders/ VC investors (shareholders) and managers make money because the customers, at least one side of the platform, are willing to pay. And they are willing to pay in return for the value they receive.

In sum, building a platform business with network effects is not lazy work, it takes a lot of patience, investments, and creative solutions to succeed. Yes, they are unlike traditional “pipeline” businesses where value flows from one direction to another linearly. They are different, and in some kinds of ways, fun. They have multiple sides of customers to deal with, and are on the toes all the time to keep the fine balance intact. These are exciting times when traditional pipeline businesses compete with platform businesses.

Comments welcome.